Advice Paper (16-21) OCTOBER 2016

A Scottish Approach to Taxation Response from the Royal Society of Edinburgh

Introduction Principles of Taxation 1 The Royal Society of Edinburgh (RSE) welcomes 5 The call for evidence highlights the four principles the opportunity to submit evidence to the inquiry the has stated will underpin being undertaken by the ’s its approach to taxation policy, namely that the Finance Committee into A Scottish Approach to system should: Taxation . • Be proportionate to the ability to pay; 2 Through the Act 2012, the Scottish • Provide certainty to the taxpayer; Parliament gained the ability to raise or lower • Provide convenience / ease of payment, and; Income Tax equally across all tax bands by 10p in • Be efficient. the pound. It also gained competency over what 6 Of these four principles, proportionality, certainty ¸ was then Stamp Duty and Landfill Tax. 1 The and efficiency relate to the design of a tax system, subsequent extended while convenience / ease of payment relates to Holyrood’s remit to give it the power to set rates operation of the system. and bands on non-savings and non-dividend income, in addition to devolving control of other 7 The RSE notes that there have been many previous taxes such as Air Passenger Duty and Aggregates formulations of the principles that should underlie Levy. From April 2017 the Scottish Government a good tax system. Adam Smith, a founding will be assigned half of the VAT receipts estimated member of the Royal Society of Edinburgh, first as arising in Scotland. 2 laid out such principles which had their most recent expression in the Mirrlees Review on 3 Over the past several years, the RSE has actively Reforming the Tax System for the 21st Century and consistently engaged with government, published in 201 17. The review stressed that in parliament and other interested bodies around a good tax system: issues of fiscal responsibility, taxation and the devolution of powers. In doing so, we have • The negative effects of the tax system on produced various Advice Papers to which we welfare and economic efficiency should be would draw the attention of the Committee: minimised; Air Passenger Duty (June 2016) 3 • Administration and compliance costs should The Scottish Fiscal Commission (November 2016) 4 be low – a system that costs less is preferable; Competitive and Fair Taxation in Scotland (July 2015) 5 • Fairness (in a non-distributional sense) is Scotland’s Fiscal Framework (April 2015) 6 achieved – for example, fairness of procedure, avoidance of discrimination, and fairness with 4 This response was prepared using the expertise respect to legitimate expectations; of a Working Group of RSE Fellows from a wide range of institutions and with diverse backgrounds. • Transparency is vital – it is always preferable The Advice Paper has been approved by the that taxpayers understand the system. General Secretary of the Royal Society of Edinburgh.

1 http://www.legislation.gov.uk/ukpga/2012/11/pdfs/ukpga_20120011_en.pdf 2 http://www.legislation.gov.uk/ukpga/2016/11/pdfs/ukpga_20160011_en.pdf 3 https://www.royalsoced.org.uk/cms/files/advice-papers/2016/AP16_13.pdf 4 https://www.royalsoced.org.uk/cms/files/advice-papers/2015/AP15_23.pdf 5 https://www.royalsoced.org.uk/cms/files/advice-papers/2015/AP15_12.pdf 6 https://www.royalsoced.org.uk/cms/files/advice-papers/2015/AP15_04.pdf 7 http://www.ifs.org.uk/publications/mirrleesreview/ 1 Advice Paper 16-21

8 The Committee is undoubtedly aware of the of payment. For example, they encompass the extensive literature on best practice for the design costs of understanding the requirements of of a tax system, including the Mirrlees Review. compliance, and providing the information The RSE would strongly recommend that such required to comply. The RSE again suggests that resources be utilised in the design and reform the Scottish Government adopt the wider-ranging of the Scottish tax system. principle of keeping compliance costs low. Proportionality Efficiency 9 The principle of proportionality would seem to go 14 The principle of efficiency stated by the Scottish beyond the principles proposed by Mirrlees in Government relates to the suggestion by Mirrlees that it introduces an element of distributional that a good tax system should minimise “the fairness. The RSE supports the idea of incorporating negative effects on welfare and economic distributional fairness as a principle. However, we efficiency” 8. It should be noted that minimising note that ‘ability to pay’ is an ambiguous concept, the negative effects on welfare and economic one which can be interpreted to be based upon efficiency can encompass the normal requirement either income or wealth. to minimise the distortionary impact of taxes. It can include using the tax system to correct 10 Proportionality might mean simply that those negative externalities that cannot be better with greater ability to pay should pay more tax, handled by other policies, for example the Carrier and there is a risk that a narrow reading of Bag Charge; and reducing opportunities for tax proportionality would suggest a system in which avoidance. The RSE supports a principle of everyone pays in tax the same fraction of their efficiency which encompasses all of these. ability to pay (a ‘flat tax’). This narrow sense of proportionality would be inconsistent with a more 15 The Royal Society of Edinburgh believes that the commonly supported principle of progressivity, Scottish Government should prioritise making the whereby those with greater ability to pay, pay a tax system fair, efficient, simple, transparent, higher proportion of income, or other measure of sustainable and consistent with other government ability to pay, in tax. policies. It is our view that there is nothing uniquely Scottish in these core tenets, which 11 The RSE recommends that the Scottish Government should apply to any system of taxation, not just should simply adopt a commitment to distributional Scotland’s. fairness, rather than an explicit principle of proportionality. Tax Reform in Scotland Certainty 16 Applying the universal principles for a good tax 12 Certainty to the taxpayer is undoubtedly system to Scotland could, however, give rise to a important, and relates to the wider Mirrleesian reformed and distinctive Scottish tax system for principle of lowering compliance costs. several reasons: Uncertainty, and the costs of resolving the problems that arise from it, contributes to • Scotland has a different set of productive compliance costs. The Mirrlees principles of assets and opportunities than in other countries; procedural fairness and transparency also • It will also have its own particular distribution address the issue of certainty. The RSE urges of various socio-economic characteristics, the Scottish Government to endorse these such as age and health; wider-ranging principles of low compliance costs, • The distortionary costs of various types of procedural fairness, and transparency. taxes will differ from other countries, for Convenience / Ease of Payment example the mobility of highly-skilled labour; 13 While the Scottish Government’s principle of • The Scottish Government will have scope to make value-based and normative judgements ‘ease of payment’ is certainly part of the Mirrlees principle of keeping the costs of compliance as on factors such as fairness, and environmental concerns. low as possible, such costs are wider than those

8 http://www.ifs.org.uk/publications/mirrleesreview/ 2 Advice Paper 16-21

17 However, the Scottish Government is not designing taxpayers (17,000 individuals) pay the Additional and implementing a completely new tax system. Rate of Income Tax compared to 1.1% in the UK Rather, the starting point is the inherited, and as a whole. In Scotland, these 17,000 people inevitably imperfect, UK system. So there could contribute 13.7% of total tax revenues 10 . This be scope for developing a more distinctive comparative lack of high earners is a challenge Scottish tax system by undertaking reforms to for the Scottish Government. the existing system that have not so far been 23 While there may be a political incentive to target undertaken by the Westminster Government. high earners through an increased top rate of 18 Moreover, under the devolved tax powers the Income Tax or Land and Buildings Transaction Scottish tax system is entangled with that Tax there should be a high level of caution of the UK, so undertaking reforms within such exercised by the Scottish Government not to a framework will inevitably lead to a distinctive shrink its tax base. High income (and generally Scottish tax system. high value-adding) individuals will have a greater level of national and international mobility than 19 It is important to distinguish between principles others and the possibility of them relocating to for the design of an entirely new tax system other parts of the UK exists. Of equal concern (as discussed above) and the practicalities of would be the possibility that in doing so they reforming the system which comes with the would take business, clients and staff with them. newly devolved powers of taxation. It is, however, important to note the huge 20 It is extremely difficult to reform a longstanding uncertainty over how mobile the Scottish tax base and ingrained structure, such as our model of is. Of equal importance to the Scottish Government taxation, through incremental steps. The will be adequate enforcement by HMRC around significant institutional changes which have Scottish residency rules in regards to taxation. occurred over the last several years, and are 24 Issues around distortion of Income Tax are also a scheduled to continue over the coming years, problem which the Scottish Government will have present the Scottish Government with a unique to address. Distortion may arise from people opportunity to effect real change in this area. working fewer hours and from people leaving the 21 The system from which we begin is far from labour market. The devolution of Income Tax now ideal in many respects. Efficiency is one of the key means that the possibility of migration in response principles espoused by the Scottish Government, to tax differences and converting income into and the efficiency of the Scottish tax system dividends must also be considered. would be greatly aided by simplification. While the 25 The Scottish Government must also carefully UK Government clearly recognises the importance consider the implications of tax competition with of this – illustrated through the creation of the the rest of the UK. Firstly, it is important to state Office for Tax Simplification in 2010 – the UK that tax competition is neither unambiguously system also contains over a thousand exemptions 9. positive nor unambiguously negative. Such Such loopholes not only provide scope for competition may force a region to lower a tax rate individuals to ‘game the system’ and avoid tax, that is too high or too distortionary, but can also but also raise questions of equity as these lead to ‘a race to the bottom’. Tax competition is exemptions are often only available to those virtually inevitable when control over tax rates is with the resources to access them. The RSE devolved to subnational regions and those recommends that the Scottish Government regions choose to set different rates. endeavours to make the Scottish tax system as simple as possible, minimising loopholes. 26 Tax competition can have both active and passive manifestations. The active manifestation sees a 22 Reform of the tax system will need to take into lower tax rate chosen in order to attract economic account some inherent vulnerabilities in the activity to a region or to counter the loss of activity system, and the base from which it draws. to regions outside of the UK. The passive The make-up of the tax base for Income Tax manifestation sees tax rates kept at the same in Scotland is noticeably different from that rate as elsewhere out of fear of tax competition. of the UK as a whole. In Scotland just 0.7% of

9 https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/198570/ots_review_tax_reliefs_final_report.pdf 10 http://www.gov.scot/Resource/0049/00497818.pdf 3 Advice Paper 16-21

27 It should also be noted that such competition with this being adjusted by estimating the proportion within the UK may be driven by factors outside of of UK tourism that is assigned to Scotland. It is the United Kingdom. An example of this would unclear whether this estimate will take into be the proposed lower rate of Corporation Tax account any action taken by the Scottish Government in Northern Ireland. This is being driven by which boosts tourism. This incentivises the Scottish Corporation Tax rates in the Republic of Ireland, Government to examine something like a hotel tax but in turn creates tax competition with Scotland. in order to ensure it collects revenue from visitors. The most salient factor in this discussion is the Furthermore, the attribution of VAT to Scotland will degree of mobility of resources between regions. be based on a relatively small sample included in It is important to stress how little is known about the Living Costs and Food Survey (LCF )11 . It is the relevant responses. highly important that the data used are sufficiently robust. 28 The increasingly intertwined and global nature of taxation means that tax bases are shared between 31 Tax cooperation between the Scottish and UK countries, and between subnational regions, and governments will be of fundamental importance that cooperation over tax rates and countering tax as a result of the extent to which they share tax avoidance is increasingly important. The Scottish bases. Scottish Income Tax payers will also pay Government finds itself in the position of being a to the UK Exchequer, for subnational actor embedded within a quasi-federal example. The RSE considers that joint reform of state. As mobility of the tax base is likely to be the Income Tax and National Insurance systems is higher between regions of the same state, than long overdue, and now can only be achieved if the between independent countries, the Scottish Scottish and UK governments can effectively Government is incentivised to levy higher taxes on co-operate, and avoid the type of adversarial non-mobile areas such as land and property. We relationship we have seen develop in recent years. note that (aside from Capital Gains Tax on real Both governments must work toward this. property) the Scottish Government now has control 32 The macroeconomic context of Scottish tax policy over all property taxes, and has an opportunity to is a significant new factor that must be considered. look at them in the round. Ideally, tax on property The nature of the new fiscal settlement means that should move away from transactions to ownership, Scotland’s tax revenues will now be very exposed so as to incentivise the allocation of property to to macroeconomic shocks. Revenues will also be productive use. exposed to macroeconomic trends that may cause 29 It is understandable that the Scottish Government, long-term divergence between the UK and Scottish or Local Authorities, would look to adopt methods economies. In turn, the Scottish macroeconomy to tax non-residents such as levies on the extraction will be exposed to shocks that arise from, or are of natural resources or on tourism. This clearly magnified by, the Scottish tax system. The RSE allows the government to raise extra revenue, strongly urges the Scottish Government to develop without putting the burden on citizens they later its tax system on the basic principles of working to rely on for re-election. While such taxes can minimise the risks to Scotland’s tax revenue of prove effective, we stress the importance that macroeconomic shocks and to minimise the sustainability and room for growth of the potential impact of the tax system on macroeconomic stability. tax base should be favoured over the opportunity 33 The devolution of new tax powers takes place in to collect potentially short-term revenues with the political climate of the UK decision to leave the little political fallout. The RSE highlights Air European Union. This has created a great deal of Passenger Duty (APD) as an effective revenue political and financial uncertainty. The decision raising tax – it also serves an important also opens up the possibility of variations in VAT environmental function – which allows the and Corporation Tax within the UK – a situation Scottish Government to tax non-residents. which previously was prohibited or constrained We reiterate our position that the rate of APD under EU law. It is important that the Scottish in Scotland should not be reduced. Government takes action to make its tax base as 30 The RSE also notes that the Scottish attribution of large as possible, rather than allowing special VAT receipts from the UK Exchequer will not exemptions. include revenues directly raised from tourism,

11 http://www.ons.gov.uk/surveys/informationforhouseholdsandindividuals/householdandindividualsurveys/livingcostsandfoodsurveylcf 4 Advice Paper 16-21

Reform of Tax Policymaking 37 In addition to a more strategic process, the Scottish Government should take action to 34 While the fundamental principles of a good tax cultivate greater co-operation between levels system remain underlying, Scotland-specific of government and, within government, between opportunities and risks exist in reforming the individual departments. Clarity over roles and system. However, the uncertainties surrounding relationships is essential. Recent Scottish tax competition and the increasing need for Government proposals to use the proceeds international tax cooperation mean that a of a reformed Council Tax for a centralised Scottish tax system is unlikely to be radically Attainment Fund serve to cloud the roles of each different from that of the UK. Where there is level of government. The RSE stresses the substantial scope for change in Scotland is importance of transparency and believes that in the adoption of a different approach to clearly defined remits and responsibilities over developing tax policy. which actors are taxing the public and spending 35 Scotland has an opportunity to move away from public money are needed. the annual cycle of a set-piece UK Budget 38 The Scottish Government could also take positive announcement controlled exclusively by the action in developing a more inclusive consultation Chancellor of the Exchequer and UK Treasury. process, which not only provides the public with The minister with responsibility for taxation does opportunities to comment on specific policies, but not own the system, and indeed relies on the welcomes their input around wider priorities. public for the raising of tax revenue. The Scottish The RSE recognises that the Scottish Government Government has not committed to mirroring has a good track record in consulting the public, the annual Westminster Finance Bill. The RSE but it must work to ensure that the information welcomes this. We recommend that the Scottish gathered, along with relevant research and the Government take this opportunity to develop a best available evidence base, is at the core of the different, and more strategic, method for its development of policy. process of making tax policy. 39 A more inclusive consultation process would also 36 The RSE notes the model adopted by New serve to strengthen public confidence in the Zealand as an illustration of best practice. system and its institutions. Transparency over 12 The General Tax Policy Process (GTPP) is how public opinion has influenced the making of a formalised multiphase process which policy and clear communication over how much follows five phases: and why the public is being taxed should be • Strategic phases: economic strategy; fiscal fundamental to the system. Informed public strategy; three-year revenue strategy. consent must be at the centre of policymaking. • Tactical phases: rolling three-year work programme; annual work and resource plan. • Operational phases: detailed policy design; formal detailed consultation and communication; ministerial and Cabinet signoff of detailed policy. • Legislative phases: drafting of legislation; ministerial and Cabinet signoff of legislation; introduction of bill; select committee phase; passage of legislation. • Implementation and review phases: implementation of legislation; post-implementation review; identification of remedial issues.

12 https://www.ctf.ca/ctfweb/CMDownload.aspx?ContentKey=16c095f4-6be3-4be7-ad2c-c2e2f252e3d5&ContentItemKey=62ed6fc7-8151-4068-8084-7dcff99d8f1a

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Additional Information Consultation responses are produced on behalf of RSE Council by an appropriately diverse working group in whose expertise and judgement the Council has confidence. This Advice Paper has been signed off by the General Secretary. Any enquiries about this response should be addressed to Craig Denham, Policy Advice Officer (cdenham royalsoced.org.uk). @ All responses are published on the RSE website (www.royalsoced.org.uk).

6 The Royal Society of Edinburgh (RSE) is Scotland’s National Academy. It is an independent body with a multidisciplinary fellowship of men and women of international standing which makes it uniquely placed to offer informed, independent comment on matters of national interest.

The Royal Society of Edinburgh, Scotland’s National Academy, is Scottish Charity No. SC000470

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